FX - Central Bank Speak to Tax Reform, Here's What to Watch

Mondays are typically volatile days in the forex market because traders adjust their positions after the weekend and initiate new trades for the week ahead. Today's intraday swings are therefore the norm rather than the exception for front of the week trade.  The greenback was all over the place today - it traded lower initially against the Japanese Yen only to spike ahead of the new home sales report but those gains did not last as USD/JPY reversed course on reports that North Korea could launch another missile test in the next few days. The dollar moved in lockstep with 10-year Treasury yields, which weaved in and out of negative territory before settling the day lower.  Despite these moves in USD/JPY and U.S. Treasuries, the greenback's weakness was limited to the Japanese Yen as it actually strengthened against the euro, sterling, Swiss Franc and Canadian dollar today. This inconsistency suggests that risk aversion had a greater impact on the currency flows than the market's outlook for U.S. dollars. That will change as the week progresses with Senate Republicans focused on building support for the tax bill, which they hope will move to a floor vote this week.  Jerome Powell also faces a nominee hearing tomorrowfollowed by speech from Janet Yellen on Wednesday.  While there are a handful of market moving economic reports on this week's calendar, central bank speak will be the primary driver of currency flows.  Today is the perfect example as traders shrugged off the stronger than expected new home sales report.  Tomorrow's trade balance, S&P CaseShiller house price index and consumer confidence report are not expected to lend much support to the greenback.

The Bank of England publishes its twice a year Financial Stability Review tomorrowand the release will be followed by a presentation by Governor Mark Carney who will share his recommendations for the banking sector.  When the report was last released in June, the BoE described the financial system as resilient but expressed concerns that consumer credit is growing too fast and ordered banks to build countercyclical capital buffers in case there is a downturn. At the time, their generally positive outlook helped to lift sterling but this time around, the Bank of England is more cautious especially since these are the toughest round of stress tests yet. Sterling will fall if more than one bank fails the tests but if the Royal Bank of Scotland (RBS) remains the only bank to fail the test, GBP should rally in relief. Either way, it should be an interesting day for sterling trade. 

USD/CAD shot higher today on the back of falling oil prices.  The Canadian dollar will also be in play tomorrow as the Bank of Canada releases its financial system review.  Although no surprises are expected, this will be followed by a press conference with Governor Poloz and Deputy Governor Wilkins.  Having raised interest rates twice this year, the BoC adopted a more cautious approach. Given the recent slowdown in retail sales and inflation growth, Poloz and Wilkins are likely to maintain this view.  This week is an important one for the Canadian dollar with GDP and labor data scheduled for release.  The risk is to the downside for all of these reports, which means we are looking for USD/CAD to break 1.28.

The best performing currency today was the New Zealand dollar, which may be surprising considering last week's softer economic reports and today's barren calendar.  NZD was driven purely by U.S. dollar weakness and NZD short covering.  Like the BoE and BoC, the Reserve Bank of New Zealand also releases its Financial Stability Report Tuesday evening. The report itself isn't expected to be a big market mover but NZD/USD traders will be watching the release along with a speech from Finance Minister Robertson Friday for any insight on the new government's plans.  The Australian dollar on the other hand gave up earlier gains to end the day unchanged.  Although there were no Australian economic reports on the calendar, the currency's gains were hampered by weaker Chinese industrial profits.

Last but certainly not least, EUR/USD ended the day at its lows after hitting a high of 1.1961. A reversal as strong as today's is generally a precursor to further weakness. It is difficult to say what caused the currency's underperformance but 1.1975 was about the level where ECB President Draghi described currency moves as volatile. Back in September when EUR/USD was trading near 1.1975, he said "the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring."  We doubt this view has changed much given Germany's political troubles and the low level of inflation but that along with the weakness of German yields are the main reasons for the euro's underperformance.  The technical structure of the pair signals a deeper correction to 1.1850.